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Private Company Capital Newsletter
TURNING AROUND THE FAMILY BUSINESS Professional football and family businesses are similar. I think it was the famous quarterback, Joe Montana, who was quoted as saying, “When I want it to be a game, they (the owners) want it to be a business and when they want it to be a game, I need it to be a business.” Family businesses are sometimes too much family and sometimes too much business. Finding that balance and enjoying financial success is rare as the challenge of separating family from business while making the best strategic business decisions relative to your competition, etc…is like having two jobs and one pay check—if you’re lucky. Family businesses often find themselves in financial distress for any of the following reasons: Ø Lack of leadership and strategic vision (not adapting to new realities) Ø Unwillingness to let outside advisors “under the tent” to point out sensitive business issues because it will open a “Pandora’s Box” of family relationship issues simmering below the surface Ø Lack of preparation for management of the business on the part of family members (being a family member doesn’t make someone the best suited candidate for the job) Ø Unresolved conflicts/weakened family ties Ø Mistrust among family members Ø Lack of loyalty, commitment to the business and unequal contributions to the business Ø Dysfunctional chain-of-command in decision making Ø “Self-think” within the family and apathy leading to insulation from market realities and need for changes In the overall scheme of life, family health is more important than the business. But, the health of the business is quite vital and often central to the family’s well being, so let’s deal with it: A Good Turnaround Candidate You know the fact pattern: consecutive years of losses, screaming vendors due to stretched out payables, lack of cash for increasing C.O.D. demands and the inability to borrow additional funds from the asset-based lender due to broken loan covenants already in effect. What path do you go down: 1. Orderly liquidation, 2. Bankruptcy re-organization, 3. Distressed Sale, or 4. Turnaround, or, “Work-out” as it’s often called? Work-out is a voluntary, informal plan of financial restructuring to avoid a bankruptcy filing or sale or liquidation. Not every financially distressed family business is a good candidate, but with changes to operations and with time and patience a family business can achieve a positive turnaround. There are three criteria for a good Family Business turnaround: Ø Family Clarity -- The family owners must be dislodged from their state of denial that the family business has always existed and will, therefore, always exist for them. They must realize the cold, hard facts and not make decisions the way they did leading up to the current situation. The family business leader, or an outside advisor, must “pound the table” with the facts, so it sinks in. Often, an outside CEO will need to be brought in to satisfy constituents. Ø Credibility – The Company cannot have gone through a restructuring plan in the past. It is nearly impossible to go back to your creditors for a second time to resolve outstanding credit issues. The longer the company has been in business and the longer those credit relationships have been in existence the better. You must have fresh credibility in asking for their help. Ø Negotiation Leverage – A liquidation analysis indicating that the cash to be raised from selling off the assets won’t cover the payments due to all unsecured creditors will usually help convince the unsecured creditors to re-work the debt because they’ll have a better chance of being made whole. This mutual need for help is vital. The Workout Process Step 1: Operational restructuring and new forecast—the first step is to develop a workout plan that fixes problems in the operations area of the business and improves profitability. If a company needs help in identifying areas of business improvement or making major changes, then the family owners can bring in a new CEO, subject-matter experts in operations or marketing, or interim management to get the job done as quickly and efficiently as possible. An up-front due diligence by an outside adviser to examine the current situation can take three weeks or more. This is an extensive review process that assesses, for example, a company's sales/marketing, operations, finances, strategy, management, and leadership. But time is of the essence when creditors are knocking at the door. If they aren't satisfied quickly, they may file suit and gain a judgment that can garnish a company's bank account and force a Chapter 11 filing. The workout plan must convince creditors that the business can generate enough cash going forward to operate in a profitable mode as well as start paying off the debt. In calculating what the company can afford to pay creditors, it is best to stay on the conservative side. For example, if the forecast is $1 million in cash next year, then earmarking no more than 30% or 40% for debt reduction allows a cushion for operational support and necessary capital expenditures. Key to the forecast is a company's cash burn position in the short term—how long cash will last given the circumstances, such as the need to pay C.O.D. to all vendors once they become more aware of the current situation. If a short-term conversion with full payment isn't possible to pay off all of the debt, based on the forecast, then a portion of the plan may be handled through stock. When determining how much debt to convert to equity, an important goal is to flip the balance sheet from a negative deficit position to positive equity. The result: more borrowing power with banks and other potential lenders and more possibilities with equity investors. In this manufacturer's case, negotiations to restructure the loan agreement with the asset-based lender began as stability was created with the creditors during the workout proceedings. Step 2: Proposal to creditors—Creditors want information—what happened, what positive changes are being made, and how they are going to get paid. That's why the debt-restructuring proposal comes in the form of a highly detailed, professional letter to all unsecured creditors. Some secured creditors also may receive the workout letter if, for example, the company has no further use for leased equipment because of reorganized business operations. The introductory section of the workout letter states the current situation: amount of debt, kinds of losses, revenues, number of creditors, and reasons behind the debt. The next section communicates the significant improvements that are in process that demonstrate the company's ability to pay back the debt. This is followed by the proposal to unsecured creditors with the terms and a one-page ballot requesting their vote of participation. In preparing the workout letter, the owner or management must be willing to not make any exceptions to the plan in order for it to succeed. In other words, it's imperative that everybody is asked to participate in the same “shared-pain” plan, even long-time business associates, friends or relatives. If creditors find out that others aren't being asked to participate, they may not want to accept the plan. Step 3: Communication and education—once the letter has been mailed, it's time to follow up with face-to-face meetings and phone calls to help creditors understand the plan and how they are going to be paid. Establishing good rapport and believability is important from the start, which can be enhanced by having a third-party facilitator involved in these meetings rather than an insider. Being accessible is essential because creditors want information they can relay to their own management in a timely fashion. Fielding phone calls from creditors and handling C.O.D. problems can be time-consuming for internal management, who should be more focused on fixing the problems and day-to-day business operations. Yet there will be times when the owner or a top manager should meet with individual suppliers to provide more details on how things are progressing.
Education is important when stock is part of the payment
because it's more difficult to persuade creditors about
the need to accept stock when all they want is their
money. It takes much more effort to convince creditors
that the workout plan—not liquidation or bankruptcy—will
improve their chances to recover their money. What's
more, many creditors are currently making money from the
troubled company by providing a product or service on
C.O.D., which wouldn't be the case if another route were
taken. Step 4: Administration—once the unsecured creditors have voted to participate, a promissory note for the debt portion of the plan is prepared and accompanies the first note payment to the creditors. Then the trade-debt cancellation/stock-subscription agreement is prepared and issued in compliance with Securities & Exchange Commission rules. When this agreement is signed by the creditors, stock certificates are prepared and mailed to each one. The number of creditors and nature of the proposal, especially when equity is involved, will determine the length of time for managing an informal workout.
In
The Final Analysis In the final analysis, some creditors may file suit and get a judgment that might force the company to pay them off. Yet in this manufacturer's case, as in many others, the combination of operational improvements and successful participation among its creditors in the workout led to some impressive results. Increasing profitability, positive equity on its balance sheet, and a normalized creditor environment provided ample opportunity to explore options with confidence at a company that at one time had seriously considered selling at a discounted price. [ Home | Our Firm | Services | Past Transactions | Research and Resources | Contact Us ] Brereton, Hanley and Company, Inc. 1500 East Hamilton Ave, Suite 102 Campbell, California 95008 Phone: (408) 938-9255 Fax: (408) 938-9259 |
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